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How Much is Real?

From China, the print on the screen
Showed GDP growth unforeseen
But how much is real?
And how much the zeal
Of regions where lying’s routine?

The dollar has retreated almost universally this morning after a pretty solid two-day run. Despite very strong US data yesterday (IP +0.9%, exp +0.5%; Capacity Utilization 77.9%, exp 77.4%) and continued positive results from the Fed’s Beige Book, traders have turned their focus elsewhere. In fact, yesterday’s themes have been largely forgotten. With all the discussion about whether or not we had seen the top in equity markets, it felt as though broad sentiment was beginning to change. But that was so yesterday! The powerful rally on Wall Street has been repeated in Asia and Europe and Tuesday’s late day hiccup largely forgotten.

With that in mind, the story with the most traction today is China, where last night they reported 2017 full-year GDP growth at a better than expected 6.9%. This comes despite the ongoing admissions by different regions within China that they have been overstating their growth rates for the past several years in order to meet central government quotas. This also comes despite the fact that some of the underlying data, notably Retail Sales, IP and Fixed Asset Investments are clearly trending lower. There is a large group of market watchers and investors, myself amongst them, which have maintained a certain level of skepticism about Chinese data. After all, given the draconian methods that the Chinese government has historically used with regard to punishment for any crimes, what regional administrator is going to willingly say that he has not achieved the government’s goals? But, it is the only data we have, and given what has very clearly become a global upswing, it shouldn’t be a huge surprise that China is growing rapidly as well. The renminbi has responded by extending its recent rally, rising 0.2% overnight, which makes a total of 1.3% in the past week. In fact, we are pushing to levels not seen since December 2015. I have to admit, that the momentum in this market certainly points to further CNY strength although I am not convinced it remains intact.

Pivoting to the G10 space, CHF is the leading gainer today, up 0.7%, although the euro has gained a solid 0.5% and is making an effort to regain its early morning highs from yesterday. And all this is occurring despite the fact that 10-year yields in the US are back above 2.60%. If you recall, one of the background stories has been the recent rise in 10-year yields here on the back of ongoing economic strength. Market technicians are focused on a yield of 2.627%, the highest level achieved last March amid the then popular reflation narrative. If yields trade above there, which could well happen today with another burst of strong US data, expectations are that we may see a fairly sharp continuation rally in those yields. That would have an interesting impact on the prevailing narrative as it would help reduce the chance of a yield curve inversion, point to a market that is expecting accelerating US growth and allow the Fed more room to tighten policy more aggressively. As I have written consistently, the Fed’s actions relative to expectations are the real market driver, and I continue to look for tighter than expected policy. Corroborating my thesis were comments from two Fed Presidents yesterday, Cleveland’s Loretta Mester and Dallas’ Richard Kaplan, both highlighting concerns that growth would outpace current forecasts and that Unemployment could well fall much lower leading to higher inflation. In other words, they are both ready to hike rates to keep ahead of the inflation curve. At the same time, Charles Evans, President of the Chicago Fed and one of the more dovish members on the FOMC, called for less policy tightening in 2018 than currently penciled in by the FOMC itself.

(Perhaps the most enjoyable story on Bloomberg this morning was the one discussing how certain cities in the west are experiencing much higher inflation than the nation as a whole, with Seattle, San Francisco and Los Angeles all sporting local inflation rates above 3.0%. This has been a theme I have discussed repeatedly in the past year. Knowing that Chair Yellen will be returning to her home in San Francisco, perhaps she will be confronted with the fact that her national data may not be indicative of much of the nation’s reality. At the very least, she will know what the rest of us are living with!)

However, this is a conundrum for me. If US yields break out higher, I think the impact on the dollar will be quite positive. And so it is surprising to me that the dollar remains under pressure as we approach levels in the Treasury market that may define that breakout. Consider, too, that the Bank of Canada raised rates 25bps yesterday, as widely expected, but highlighting the turn in broad central bank policies. In the end, my thesis remains that the Fed is more aggressive than currently expected by markets, and that the dollar benefits accordingly.

This morning brings us new data including Initial Claims (exp 249K); Philly Fed (25.0); Housing Starts (1275K); and Building Permits (1295K). Further strength in this data set, especially the housing data, should continue to lay the groundwork for a more aggressive Fed. It’s funny, when there is a discussion of equity markets, a common theme is ‘don’t fight the Fed’. But in the FX markets, I would argue that is exactly what we have seen for the past year. I still like the dollar higher over time, but unless today’s data is extraordinary, we probably have a little more weakness in the immediate future.